We Think T.RAD's (TSE:7236) Profit Is Only A Baseline For What They Can Achieve

The subdued stock price reaction suggests that T.RAD Co., Ltd.'s (TSE:7236) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

See our latest analysis for T.RAD

Zooming In On T.RAD's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, T.RAD recorded an accrual ratio of -0.17. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of JP¥9.8b during the period, dwarfing its reported profit of JP¥1.25b. Given that T.RAD had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥9.8b would seem to be a step in the right direction. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of T.RAD.

The Impact Of Unusual Items On Profit

T.RAD's profit was reduced by unusual items worth JP¥1.2b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If T.RAD doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On T.RAD's Profit Performance

Considering both T.RAD's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon T.RAD's statutory profit probably understates its earnings potential! With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Our analysis shows 3 warning signs for T.RAD (1 is a bit unpleasant!) and we strongly recommend you look at them before investing.

Our examination of T.RAD has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.